UMS Holdings - Dragged By Applied Materials’ Weaker Outlook

Key client Applied Materials (AMAT)’s disappointing sales outlook may have negative implications for UMS over the near term.

But underlying demand drivers remain supportive longer term.

Ahead of a recovery in order flows, UMS’s attractive prospective yield of 7.4% should help hold up the stock.

Downgrade to HOLD with a lower Target Price of S$0.86, mainly as we impute lower growth for FY18F-19F.

Downgrade to HOLD with a lower Target Price of S$0.86 as AMAT’s disappointing sales outlook may have negative implications for UMS over the near-term.

During its recent 3Q18 results, Applied Materials (AMAT) gave a disappointing sales outlook, which could directly impact UMS’s Endura business (which contributes c.50% of top-line, on average) over the near term and give rise to a weaker 2H18 vs 1H18.

To reflect this, we have lowered our earnings projections for FY18F/19F by 9%/14%, mainly on more conservative revenue estimates. Against a valuation multiple of 10x FY19F PE, we arrive at a lower Target Price of S$0.86.

Downgrade to HOLD, as UMS’ prospective 7.4% yield should limit any further significant downside to share price.

Where we differ:

~ SGinvestors.io ~ Where SG investors share

We have assumed a larger discount to larger peers’ 12x FY19F PE compared to consensus given its higher customer concentration risk vs peers.

Potential catalysts:

Notwithstanding fluctuations in near-term operating performance – which are typical of semiconductor-related stocks, the vast application potential of chips is set to drive robust demand growth for semiconductor equipment over the medium-to-long term. This augurs well for UMS given its primary role in the manufacture of components for various semiconductor equipment and sub-assembly for Applied Materials’s flagship Endura deposition system – especially given the successful extension of the Endura contract in early 2017.

Key Risks to Our View:

Key client risk. Historically, c.90% of UMS’s revenues on average can be attributed to Applied Materials. Disruptions to the relationship or weakness in Applied Materials’s end-demand could significantly weigh on UMS’s performance.

WHAT’S NEW - Offers prospective 7.4% yield ahead of recovery

Applied Materials’ disappointing sales outlook suggests that UMS’s sales performance could be impacted over the near term.

During its recent 3Q18 results, Applied Materials gave a disappointing sales outlook, which could directly impact UMS’s Endura business over the near term.

While a faster-than-expected ramp-up on its higher-margin Components segment could help offset weaker demand for Endura and defend its industry-leading margins, we choose to be more conservative on UMS’s near-term sales outlook for now as it will likely take time before efforts to further cultivate this segment bear fruit.

But underlying demand drivers point toward a steady growth profile over the medium-to-long term.

Near-term expectations aside, rosy demand forecasts for chips in attractive end-sectors such as automotive and IoT also bode well for semiconductor equipment companies’ prospects over the medium-to-long term.

EARNINGS AND RECOMMENDATIONS

Downgrade to HOLD with a lower Target Price of S$0.86, mainly as we lower sales assumptions for FY18F-19F.

While UMS typically delivers a seasonally stronger second half, we believe that Applied Materials’ weaker outlook guidance could spill over to UMS as soon as 3Q18 given short order lead times, which may result in a weaker 2H vs 1H18. As such, we now assume a 15%/4% decline in FY18F/FY19F sales vs 5% growth p.a. previously.

There are slightly higher gross margin assumptions of 55%/57% for FY18F/19F to reflect management’s optimism over increasing contributions from the higher-margin Components segment in subsequent quarters.

Overall, we lower FY18F/19F earnings by 9%/14% respectively and arrive at a lower Target Price of S$0.86 (based on 10x FY19F earnings). Downgrade to HOLD.

UMS has been paying 6 Scts per share each year over the last five years, and at least 5 Scts per share historically. All else equal, we believe a 6-Sct dividend for FY18F is achievable for UMS given steady operating cash flows and net cash of > S$20m (which translates into c.4 Scts per share) which can be used to support dividend payments in the event of fluctuations in operating performance.

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